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The Future is Multi-Echelon Inventory Optimisation

  • 5th August 2015
  • Categories: News

KPMG Synopsis based on a presentation by Shaun Gates at this years Smart Conference

Rather than blindly sticking to the same supply chain path and inventory levels, multi-echelon inventory optimisation takes a holistic view and configures the supply chain as required to ensure it is always delivering the best results for the business.

Multi-echelon inventory optimisation involves making intelligent choices as goods navigate their way through your supply chain network?- improving efficiency, optimising inventory levels at each node and providing the flexibility to work around unexpected events. You might think of it like investing in a sat-nav to devise the best route as you drive across town each day. Your intelligent co-pilot considers current traffic conditions, road closures and running costs when planning each days journey, taking the optimal path rather than blindly leading you into the heart of a traffic jam simply because thats the way youve always gone.

Managing the bullwhip effect

“Even when customer demand for a product is steady, its flow through a supply chain experiences peaks and troughs which need to be managed,” says Shaun Gates, Managing Partner at Lexian Solutions.

A grocer might experience consistent daily demand for a simple product like paper towel, but the wholesaler probably only delivers stock once per week. Further up the supply chain the demand becomes more staggered ? the factory may only produce that particular product once a month and the raw materials might only be ordered every few months.

Each node in the supply chain requires a minimum safety inventory level to ensure regular supply to the next node and avoid disruptions for end customers. The further back you travel along the supply chain, the higher those safety inventory levels need to be in order to cope with the larger peaks and troughs. Its not practical?- in terms of cost or reliability?- for the factory to receive small daily shipments of raw materials corresponding with daily sales rates at the other end of the supply chain.

The design of the traditional supply chain means that even small fluctuations in consumer demand can send large ripples up the chain, leading to insufficient production or excessive inventory at different nodes.

“Its call the bullwhip effect,” Gates says. “You might crack the whip with a slight flick of your wrist, but as that flick works its way along the whip its amplified into larger and larger peaks and troughs.”

“Multi-echelon inventory optimisation, or MEIO, chooses the best path for products to travel along the supply chain. The aim isnt just for speed and efficiency, but also to optimise stock levels at each node along the way to reduce those peaks and troughs.”

Nodes in a traditional supply chain generally only speak to their neighbouring nodes, passing demand up the supply chain and goods down the chain. MEIO grants each node visibility over the entire supply chain, allowing them to lower safety stock levels, choosing alternate supply paths for greater efficiency and take into account variables like lead times and transport costs.

“Most businesses have experienced at least some aspect of this, even if theyre making the decision manually,” Gates says. “For example, do you get your incoming container ship to deliver separate consignments of dishwashers to Melbourne, Sydney and Brisbane? Or do you make one big delivery to Sydney and then freight some of those dishwashers to the other cities?”

“You might have settled on a Sydney-only delivery as your permanent option. MEIO would regularly re-examine every possible scenario?- even the seemingly impractical ones?- in search of overall supply chain optimisations which could help give the business a competitive advantage.”

Moving back along the supply chain, MEIO can also influence where in the world components are sourced and where production takes place, as well as how they get to where they need to be.

Successfully employing MEIO requires detailed knowledge of the business in order to accurately assess each variable and every alternative. For example, the path between each node in the supply chain has its own pack size limitations and shipment frequency, along with transport and handling costs. There may be seasonal demand fluctuations and other variables which influence product flow along the supply chain, further affecting the supply, demand and stock level at each node.

Step changes in cost

Under the traditional fixed supply model, with a single path, any improvement to service levels between nodes costs the business more money. Costs increase roughly on a curve, corresponding with improved service. MEIO changes the relationship between service levels and cost, because it is often possible to reconfigure the supply chain to meet your new objectives without necessarily spending more money ? just changing the path and spending it in different places.

Rather than a steady cost increase, under MEIO you experience step changes in costs when you reach certain thresholds ? such as making the step up from sea freight to air freight when it becomes the most practical option. As a result MEIO can decrease costs by up to 20 percent, Gates says, at the times when it can avoid going up a step. For example the flexibility of MEIO might sometimes find a way to get products from A to B without the need to resort to air freight, whereas the fixed supply chain model couldnt devise a plan to avoid that extra expense.

“With traditional inventory optimisation youve got blinkers on, you dont get to see whats happening up and down the chain,” he says.

“You also make a lot of assumptions, such as where demand is coming from, what your service levels are and what your replenishment quantities are. MEIO takes a much more holistic view, determining these variables for the best possible outcomes rather than just going on your assumptions.”

The ability to examine every option at your disposal, and weigh up the wider consequences, means that MEIO is also better equipped to deal with Black Swan events ? incidents which you didnt anticipate but impact on the efficiency or reliability of the supply chain.

“You can see the impact of a Black Swan event on the entire supply chain,” Gates says. “This makes it much easier to chart the optimal route around the problem, perhaps by doing things differently rather than simply throwing more money at the problem.”